Offshore advisors could find themselves on the wrong side of the law if they fail to identify where their clients are truly based, our legal columnist Rebecca Leon of Baker McKenzie writes.
In the classic childrens book by P.D. Eastman, Are You My Mother?, a baby bird tries to determine which animal is its mother. After questioning many different species, the hatchling finally identifies the mama bird as its mother. Firms must engage in the same inquiry to identify their clients.
Those in the securities industry throw around the words client and customer, and yes, they have technical definitions and exceptions under various US laws, as well as under foreign laws. These terms are also frequently used more colloquially. However, using such terms loosely and failing to properly identify your client creates significant risks (beyond licensing and AML) that can lead financial services firms to unintended violations of foreign law.
Unlike the childrens book, which ends with the baby bird finding its mother and the two birds resting safely back in their nest, recognizing your client is just the first step to uncovering hidden risks.
For example, Individual A in Argentina is the sole owner of a personal investment company (PIC) organized in Bermuda. Aside from a director appointed in Bermuda, the PIC has no other connections to Bermuda. Individual A will decide which financial advisor to hire, and in which products to invest the PICs account assets. The financial advisor communicates with Individual A and the PICs mailing address is in Argentina. Financial advisors frequently refer to Individual A as their client. This makes perfect sense because their relationship is with individual A, the decision-maker.
However, on the firms books, the client is the PIC, and the PIC is organized in Bermuda. The firm and the advisor have identified a different party as their client. Which one is the client for purposes of determining the applicability of foreign law? Must the firm consider the laws of Argentina and Bermuda regardless of who the client is?
Consider a more complicated structure where a PIC organized in Bermuda is owned by a trust legally established and administered in New Zealand, where the grantor of the trust resides in Argentina (Individual A).
Communications are with the trustee in New Zealand, but the account was opened by the PIC. The financial advisor may consider Individual A who set up the structure for his own benefit to be her client. Once again, on the firms books, the client is the PIC. Must the firm consider the laws of Argentina, Bermuda, or New Zealand?
You probably guessed the answer: the laws of all jurisdictions that have a connection to the account should be considered. Whether a particular countrys laws are applicable to the relationship will depend upon the facts of each client and the specific areas of law.
For example, if the client is a PIC and its only relationship to a particular jurisdiction is that its organized there and one director resides there, the securities laws of such country may not apply. The rationale is that any offers of securities products and services are being made to a person outside the country (e.g. to Individual A).
On the other hand, Individual A may be considered to be acting as an agent of the PIC. Under this interpretation, the laws where the PIC is organized apply since the PIC is the client to whom the products and services are offered through its agent. The firms identification of the client and the financial advisors identification of the client may both be correct when it comes to determining whether the laws of each country apply to the client.
In the examples above, assume hypothetically that Bermudas securities authorities take the position that local securities laws do not apply to the offer of products and services to the Bermuda PIC since all communications are with Individual A in Argentina.
However, if the director in Bermuda must send over a copy of her drivers license for the firms KYC records, the firm will be processing the personal data of the Bermuda resident. The firm may also be sharing that data with its clearing firm and other third parties. The firm must explore whether Bermudas privacy laws apply and whether they impose any requirements on the firm.
Of course, the firm must also analyze whether soliciting and advising Individual A in Argentina would trigger the application of any Argentine laws. Will this be viewed as offering services and products in Argentina? Will Argentine privacy laws apply to the personal data of Individual A received by the firm even though the client on the firms books is a Bermuda PIC? Will margin interest received by the firm be subject to withholding tax under the laws of Argentina? Will any consumer protection laws apply? These questions should be asked because the risks go well beyond potential violations of US anti-money laundering laws and foreign licensing requirements.
The first step to mitigating risks is identifying the risks, which starts by asking: Are you my client? Then the firm should consider the laws of all jurisdictions that relate to the client. Firms should document this review and take appropriate steps to mitigate the identified risks. Such measures can help minimize regulatory and enforcement risks, as well as private litigation.
And so... the firm and its advisors can rest safely (well, as much as possible in this business) in their nest (or home office).
Rebecca Leon is a partner at law firm Baker McKenzie, focusing on legal and compliance matters for US wealth management firms, broker-dealers, and banks.
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